'Un-sexy is good business,' and other rules from Scott Rafer

Last Friday I sat down to lunch with Lookery-cofounder Scott Rafer. Over Thai noodle soup and green papaya salad, I got an earful on why Rafer thinks entrepreneurs ought to be buckling down and preparing themselves for some hard knocks in the market.

A student of history, Rafer believes we are no more than 5 months away from the next bust. He is popular for being opinionated – even “blustery” to those who know him better than I do. But Rafer draws on a lot of experience: he has launched something like 8 startups, among the best-known are: WiFinder, Feedster, Mashery, and most recent, MyBlogLog, which Yahoo! bought for $10 million in January. (There are more companies, Rafer says, but ticking them off for a reporter grew tiresome. “I can’t even remember them all,” he claims.)

Blustery or not, there is wisdom in his perspective. I’ve summarized Rafer’s lunchtime musings, which might as well be called Rafer’s Rules for Surviving the Bottoming-out of a Market Cycle.

Rafer’s Rule #1: ‘Un-sexy’ is good business. This is a riff on a market principle Rafer picked up from a couple of his ancestors back east: one who ran Rafer’s Kosher Meats; and his grandfather, who ran Rafer’s Army Navy Surplus (both were in business in the 1950s, long before Rafer was born.) The idea here is that there is potential in furnishing a (seemingly) boring business that plenty of people need, but which few people want to do — a.k.a. stuff that ain’t sexy. Which also means you’re likely to have a reliable market for your business, and might not have so much competition — good!

In the digital world, as Rafer explains it, the equivalent of the Army Navy Surplus Store translates this way:

“Find a reason for hundreds of thousands of people to send you their useless data. Aggregate it. Organize it. Give it a value. Which means you can monetize it, and you have a business. My exmaple of doing this was MyBlogLog.”

Rafer’s Rule #2: Every Silicon Valley business cycle is at most 8-11 years. Rafer says every entrepreneur must commit to memory the history of business cycles in the Valley. This is because it’s important to be able to evaluate the prospects of a current venture in the correct context — a.k.a the stage of the market cycle in which your startup will be struggling to survive. Will you be launching at the bottom of a market, where prices are low and competition is slight?; in the middle, where differentiation is your edge?; or at the top where prices are bloated and deep pockets are about all that makes the difference? You need to know, because it changes your odds, and therefore, will change your strategy.

Rafer’s historical cliffsnotes on Valley Cycles:
1950’s: The Mainframe cycle
1960’s: The Minicomputer cycle
1970’s: The Microprocessor cycle
1980s: The PC Cycle
1995 to March 2000: The DotCom Cycle
March 2000 to 2008: The Web2.0 Cycle

“Every single one of these cycles lasted between 8 and 11 years. The 8-year anniversary of the last collapse is in March 2008. Now, if someone wants to stand up and tell me why this cycle is somehow going to be a longer one — I’m all ears,” says Rafer.

This doesn’t mean you shouldn’t be investing in new business, BTW. Obviously Rafer isn’t sitting on the sidelines. He launched Lookery in July. “It does mean you have to be willing to invest in businesses that you’re happy to stay in until 2012 — when the [next] cycle comes back around.” (Translation: If you’re ‘founding to flip’ today, 5 months before the anniversary of the dotcom bust, you’re probabvly too late.)

Rafer’s Rule #3: Pay attention to politics. Rafer doesn’t say this stand on his soapbox. “In general, governments are friendlier to one of two kinds of businesses: capital intensive businesses (think oil, auto or military/aerospace industries) or IP intenstive businesses (this is you).” It’s just important, Rager thinks, for your own planning, to know which of these two “disciplines” an administration is likely to favor more. It’s too obvious for Rafer to say that this matters because an administration’s “inclination” will influence things like tax policy. But it could also influence trade and labor agreements; regulation; even, potentially, Supreme Court decisions on contract and IP contests. This isn’t a hard litmus test for you to do, but it is worthwhile.

Rafer’s Rule #4: The Cost-per-Click model is not elastic. The financial model for most Web2.0 startups is based on “cost-per-click.” We all know this. But, says Rafer, in such an auction market, the costs aren’t linear. Which is to say a small portion of the cost-per-click auctions disproportionately affect the overall market. “[Costs-per-click] prices are ruled by a bunch of VCs bidding up [adwords] terms like ‘digital video.’ So the pricing on the last 3% are the bids that bloat the costs-per-click,” says Rafer. Why is this bad? Because it means only a very small percentage of bidders, with an interest in a very small number of terms, need to lose their enthusaism to impact the market in negative way, and for an $8/cost-per-click to deflate to a $2 cost-per-click. “Those 3% of bidders at the top drop off, and suddenly Google is no longer a $600 stock,” warns Rafer.

Rafer’s Rule #5: The best defense is to play at the bottom from the start, where such deflation in pricing won’t impact your business as much. “This is why Lookery’s business model is what we call a remants business,” Rafer says. So Lookery serves up ads to users of social networks based on demographics such as gender, age and location. (The networks get paid for sharing the data of their users, which is privacy-protected, with advertisers.) But Lookery isn’t focused on the high-end, flashy advertising stuff that seeks $15 CPM-sites such as AOL or Yahoo!. Rafer says Lookery serves up ads to sites that command “the bottom of the pyramid,” where prices are $.25 per CPM. So Lookery’s value proposition is still to deliver refined marketing, but “our intent is to fix the bottom of the pyramid, where costs are steady between $.10 and $.60 [CPM]. The ads in my business won’t be driven [up or down] by overbidding or marginal demand.”